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He uses a simple example: If you had $100 to invest in stocks and bonds, you would divide that money between the two asset classes based on their volatility, with greater volatility meaning greater risk. So, if stocks were three times as volatile as bonds, then to keep the risk of each asset class at parity “you’d put three times as much in bonds” as you would in stocks, says Mr. Ablin. In this example, that means $25 in stocks and $75 in bonds.

The ideal balance between stocks and bonds, using this approach, has shifted dramatically recently because of falling stock volatility. “Over the last six months, the volatility differential between stocks and bonds reached its narrowest point since 2004,” says a recent BMO Private Bank report.

That means risk-parity portfolios of stocks and bonds should have been adding to their stockholdings and scaling back their bondholdings. The BMO report cites a recent report from
Morgan Stanley
that showed the equity allocation for a theoretical risk-parity portfolio of stocks and bonds was north of 40% of the portfolio, versus less than 20% in late 2000. In July, that equity allocation stood at 39%, according to Morgan Stanley.

But if stock volatility increases, then risk-parity portfolio managers will sell some stocks to buy more bonds and so maintain the risk parity. In that case, there’s the potential for a “vicious, volatility induced selloff” of stocks, says BMO, which adds the trend is “worth watching” even though the amount of money that would be involved in such trades is likely low.

Mr. Constable is a writer in Edinburgh, Scotland. He can be reached at reports@wsj.com.

Appeared in the August 7, 2017, print edition as 'Risk Parity.'

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